Protect your family with a partnership

Look at it this way: If you can buy an asset for $1,000 and have complete control over that asset, it has to be worth more than a limited partnership interest where you have no control. The value of the limited partnership interest must be less than the market value of the asset because you don't control the money. All of the courts that have reviewed this, and even the IRS, agree that there must be a discount. The more liquid (meaning cash), the lower the discount. The IRS historically has allowed a discount of about 40%, depending on the assets transferred. That means that the parents can transfer as much as $11.67 million in assets structured as limited partnership interests without paying any federal transfer taxes. (60% of $11.67 million is the $7 million credit exclusion for 2009.) That's $4.67 million more than they could without the limited partnership.

The IRS argues that this is unfair to those who are unaware of the law or who can't afford high-priced attorneys to draft partnership agreements for them. And anyone who's married and has an estate of less than $7 million in 2009 can, if his will is appropriately structured, pay no federal gift or estate taxes. The FLIP is a real tax benefit only if your estate is $7 million or more. If you have that kind of money, you can afford to pay for competent estate planning.

Lower tax brackets and asset protection

The IRS does have one legitimate concern. In some cases, taxpayers have tried to take outrageous discounts of as much as 90%. Unfortunately, some people try to cheat; that's why we have audits.

Also, since the children as limited partners own 99% of the partnership, 99% of the income will be taxed to them. This also has concerned the IRS. Traditionally, the parents will be in a higher income tax bracket than their children. If the parents are in the 35% bracket (the top rate for 2009) and the kids are in the 25% bracket, we have reduced the tax bite by 10 percentage points.

A FLIP also provides asset protection. Before the transfer, 100% of the parents' assets were subject to their creditors, now only 1% is exposed.

But what if the kids are sued? Well, against a limited partner, a creditor can get a judgment called a "charging order" only. This places the creditor in the same shoes as the limited partner. So if the partnership earns $100,000 and the limited partner owns 99%, the creditor is going to be taxed on $99,000. But as general partners, the parents decide whether to distribute any cash to the limited partners. So the creditors could then end up getting taxed on $99,000 in income every year, even though the general partners aren't giving them a single penny. This is a great motivator for creditors to settle.

The increase in the exclusion amount means that fewer taxpayers will have to use a FLIP to reduce their estate tax, at least until 2011. Few tax professionals believe that the unlimited exclusion will remain or that the reduction to $1 million in 2011 won't be changed. But in any case, FLIPs will still provide creditor protection and potential income tax reduction, regardless of what happens to the estate tax.

Family limited partnerships are legitimate wealth-preservation and asset-protection structures. Just because they are costing the government tax money doesn't make them bad. Remember, it's your money, not theirs.

Updated July 6, 2009

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